The FNI crash: the lessons – Analysis by Lucian Croitoru
In a developed market economy, the bankruptcy of an investments fund the size of FNI would not have created too much panic. In a normal economy, bankruptcy is a sign that the golden rule of the market economy works – diseased entities that are unable to survive are eliminated to keep the system sound. In our country, bankruptcy has not been regarded as a solution to improve the economy. There have been groups interested in cumbersome bankruptcy legislation so that state enterprises would not legally go bankrupt although factually some of them are. Among the effects of this situation is the deteriorating health of the economy and the consolidation of the entirely mistaken idea that when it does happen, bankruptcy must receive government assistance. The situation leads to more costs for the society, but some interest groups make a profit.
If we were to have a healthy economy, it would not have been worth the effort to write about such an event as the FNI case. But our economy is far from healthy. Therefore, a few lessons need to be disseminated from this case.
Investors with these funds must learn that high-return placements are usually associated with relatively high risks. This means that when the risk reveals itself, the investment may be lost.
There are a few lessons for state institutions, too. First, that the prudential regulation of the capital market, however comprehensive, is still insufficient unless mechanisms are in place for an effective oversight of market operators. In the FNI case, precarious oversight apparently permitted an unwanted mixture between poor management and fraud. The FNI failure also points to the need to strengthen oversight of banks that invest in non-banking financial institutions. If this lesson is well learned, such problems will not repeat in the future.
The second lesson is the contamination effect that stems from the failure of a financial institution, albeit with a limited number of investors. The FNI collapse, doubled by groundless rumours about the BCR situation, might have caused a massive contamination by degrading public confidence in the safety of the financial system. The contamination has been avoided by an efficient cooperation between the BCR and NBR. But there are plenty of instances around the world when it could not be avoided.
The third lesson is about popular banks. A proper regulating and oversight framework will have to be set into place for them as fast as possible.
And last, there is the lesson that it is more efficient for institutions to internalise predominantly proactive rather than predominantly reactive behaviours. After this last lesson is assimilated, too, questions such as “Why does it take an unfortunate incident before authorities take action?” will not spring up too often. Until then, however, the answer to such a question can only be this: because we cannot (or perhaps don’t want to) provide the proper incentives to make institutions proactive.
Nothing new on the financial market – Analysis by Claudiu Doltu
In purely economic terms, the recent events around FNI and BCR are nothing spectacular. As to FNI, we must first say this – virtually everyone knows that profit is directly proportional to risk. And FNI investors were attracted by the very prospect of gaining on their placements much more than other investment funds provided. Had the FNI not collapsed, investors would be enjoying their inspiration and congratulating themselves for assuming the risk of making this placement.
Second, it was common knowledge that the bulk of holdings in the FNI portfolio were unlisted shares, which raises two major questions, one, about the fund’s liquidity, and another, about the verity of the fund’s market value. It is too late to ask now: “what is a portfolio?”, “what is listed/unlisted,” “what is liquidity,” or “what is market value?”
Many commentators of the FNI event blamed it on the association of the CEC ensign with FNI’s. “This combination encouraged people to place their money with the FNI, feeling their money was backed by CEC – an institution with rock-bottom safety!” Excuse me, but selling another illusion to the people – “state financial institutions are rock-bottom safe” – is a big mistake. No financial institution is “rock-bottom” and no placement carries zero risk. Only two years ago, the financial crisis in Russia was triggered by the state itself, which failed to redeem its bonds on maturity.
As for BCR, events surrounding it are nothing spectacular and even fail to show the “weakness of the Romanian banking system.” In banking systems with fractional provisions (as most banks of the world are today) no bank will hold if pressure from deponents continues for long enough. BCR held not because it was “the largest Romanian bank” or “Romania’s flagship bank” but because deponents’ pressure ceased only a few days later and because distrust was not sustained in its case.
Indeed, average people are not required to know how a banking system operates. But average people know the relationship between profit and risk. At least now, people should learn that in an economy, the financial market is only an intermediary between those who save and those who borrow money to invest or spend. Banks and investment funds are nothing but intermediaries on the financial market. They are in no case charity organisations, as the government itself cannot be expected to keep a vault available to repay those who, under their own judgement, put their money on the financial market and eventually lost.
Anywhere in the world, when a bank or a major investment fund reaches bankruptcy, many years pass until the public learns what was behind the affair in question. Who was “behind the deal,” who “bought” whom, what special services are involved (if any)? Even if such (truthful) answers will come, they will be no more than mere events that cannot make up for investors’ lost money, or for their ignorance of elementary economic notions. To the public acquainted with economic issues and for those who are professionally involved with studying the economy, these events on the financial market may be of interest, in a few months.
Romanian Beauty – Analysis by Valentin Lazea
The FNI crisis brought up a string of major flaws in our society, such as the recklessness of a large portion of the populace and the goofy populism of some politicians. However, it also brought new hope, seen in banks’ solidarity and in the public debate over how certain financial empires were built.
The irresponsible citizen, who does not think at all and expects miraculous solutions from the state to mend his folly is, unfortunately, a legacy of communism we won’t be losing any time soon. The notions of assumed risk, potential loss, personal liability, are still regarded as exotic plants in our hinterland.
To boot, a number of so-called politicians rushed to capitalise on the event, spilling out crocodile tears on the shoulder of the poor swindled investor. These people cannot see beyond the length of their noses and would not be able to lead even an apartment bloc. Because the real political economy issue is this: if, out of social, humanitarian and other reasons, the state provides reparation from any financial fraud, who can guarantee such fraud will not spread like a scourge? And how can a country be ruled when every taxpayer is called to make up for the financial fantasies of a few hundreds of thousands of simpletons?
As to the filled half of the glass, it was remarkable how united commercial banks were in their actions, for the first time in this decade. They realised that an attack on the BCR was an attack on the entire banking system and acted accordingly, tightening their rows.
And the magnates who own genuine financial empires should know they are public scrutiny and could always be called to answer for some things of the past.
As a general conclusion, the net impact of this crisis has been negative, not because it questioned Romania’s foreign image, so laboriously pieced together, but because for a few days it replaced a number of crucial reform measures on the government agenda. This is the beauty of Romania: a country that needs to put reform in top gear wastes time on other matters, entirely collateral.
Counting time – Analysis by Dragos Negrescu
Two years ago, I voiced concern that the Romanian capital market was very far from responding to real needs and had many attributes of an artificial construction, built rather out of the want of reputation. I will not delve into the reasons why the Romanian capital market lacks the most important segments (primary offerings that mobilise fresh capital, or corporate and government bonds), but I must admit it has neither the depth nor the minimum liquidity and sophistication needed to foster a prosperous mutual funds industry. This is the profound economic cause of the large-scale failures suffered by FMOA in the past and, more recently, the FNI. Both have been faithful to “investments” in instruments utterly atypical for a capital market with at least a hint of maturity: promissory notes and unlisted shares.
Second, the FNI crisis revealed attitudes and expectations on the part of investors that border on the irrational. Warning signs that have been known for years, such as the massive component of unlisted shares in the portfolio and yields much above inflation (for that matter, above any other mutual fund on the market) were systematically ignored, not out of the wish to preserve their money’s buying power, but out of that to obtain high real-terms returns, some kind of “windfall gains.” It is “bon ton” these days to accuse such judgement of cynicism, but I believe a decision to compensate FNI investors would help perpetuate neglect of the risk attached to “abnormal” gains.
Third, the oversight mechanism has again proved utterly inefficient. Without absolving the CNVM of its enormous culpability, I must remind that – in the previous case, the FMOA – the Commission was blamed of the very opposite to what it hears now: of having accepted a gradual move to the prudential limits on the amount of unlisted shares.
And last, suspicions are very strong of major wrongdoing on the part of some FNI managers, and they will probably be proved. This episode, although much more grave than the others, is not singular against the background of an extreme laxity in doing business in Romania. Spectacular arrests and handcuffed individuals before cameras cannot replace a climate of business safety, where sanctions can and must be applied even before (and/or in the absence of) criminal sanctions. An excessive politicisation of such cases explains this hiatus. It allows many to create around themselves an aura of martyrs “persecuted” by the authorities, in hopes of scoring points in their dispute with political opponents. Although the twelfth hour is nearing, we still have the chance to pull the financial scandals from under the empire of politicianism, leaving the proper institutions to investigate in complete serenity and without interference or politically scented admonishments.
Post-FNI developments – Analysis by Florin Pogonaru
In the FNI case, before analysing investors’ behaviour, we must look into how they were protected by the institutions of the capital market. What strikes is the frailty of institutions before the pressure of political or group interests. This leads to “management by ambiguity” or, in any case, by postponing the decisions that could affect those interests. The fact that such institutions are left to the whim of the political is also reflected in how sanctions in similar cases were completely different in post- and pre-electoral periods. The same political milieu that constantly produces time bombs such as Caritas, SAFI or, this time, popular banks. In the case at hand, when these institutions were self-regulating, the gregarious spirit that haunts the players on the capital market has certainly favoured the FNI tragedy. Small investors once again learned the lesson that “what is too good to be true isn’t true.” But before accusing them of greed or lecturing them that the state cannot compensate their loss, it is worth considering who and how was able to drag into such a scandal institutions that bear the state’s guarantee of sovereignty. Which are the predictable consequences for the times to come? With the capital market compromised once again, we are likely to witness an orientation of people’s savings toward the banking system, especially foreign banks. Exposure to hard currency among popular savings will also likely grow. With a lot of liquidity on their hands, banks can be expected to develop new products, including some for the capital market. They will increasingly target direct or indirect placements abroad or placements on the Romanian market (some as equity investments). In the medium term, we may witness a development of capital market products in banks, through various intermediaries or directly. We will witness a revision of the oversight mechanism for financial markets, this time under the influence of international financial institutions (especially the IMF). In the meantime, Romanian financial institutions should preferably become more responsible in promoting competent management. Market players should also be expected to become more competent. But since this requires time, we will see a number of capital market “players” leaving the market under the impact of stronger oversight. The compromised capital market will probably postpone legislation on pension funds, thus increasing – in the medium term – pressure on domestic debt.